Late last year, a judge in a class-action suit by WorldCom bondholders made a decision that boded ill for underwriters. In December, U.S. District Judge Denise Cote ruled that JPMorgan Chase & Co., a lead underwriter for WorldCom shelf offerings in 2000 and 2001, was not entitled to "blindly rely" on the company's clean audit opinions. A few months later, after Cote raised the possibility that Morgan could be on the hook for the full $10 billion underwritten by the syndicate it had co-led, Morgan settled for a staggering $2 billion.
"If you're an underwriter doing an offering today, the critical question is, 'What, if anything, do we need to do differently to protect ourselves in case this thing blows up?' " says Brian Pastuszenski, a senior partner at law firm Goodwin Procter LLP in Boston.
If underwriters are now expected to scour issuers' financial statements, will that, in turn, stall deals? Perhaps, but so far, not much has changed.
When Larry Trachtenberg, CFO of Tempe, Arizona-based Mobile Mini Inc., filed a shelf registration in early May, there was just one deviation from previous offering processes: his legal counsel advised vetting the S-3 with attorneys for the investment banks he had used before, Deutsche Bank and CIBC. Trachtenberg says he isn't concerned about underwriters' jitters holding up any future deals. "We keep them apprised of what's happening in our business," he says.
The Bond Market Association has no less than six member task forces examining underwriter due-diligence practices. Yet Marjorie Gross, regulatory counsel for the BMA, insists, "Many of our members are already doing a good job in performing continuous due diligence on frequent issuers."
"It wasn't a lack of due diligence [by underwriters]; it was that what came out of the due diligence never made its way into the offering documents," counters Lynn Turner, a principal at governance watchdog Glass, Lewis & Co. in San Francisco. Turner believes that banks failed in their role as gatekeepers and likely ignored obvious problems in order to capture their fees. After all, even as Citigroup's investment bankers were hawking WorldCom's $11.9 billion offering in May 2001, its commercial bankers were advising the bank not to lend WorldCom another dime.
So long as the settlements that banks pay pale in comparison to profits, transparency will not improve, Turner argues. He advocates an inspection board for underwriters similar to the Public Company Accounting Oversight Board for auditors and stiff fines that would claw back any profits gained from faulty offering documents. "If [underwriters] know that the risk is high enough," he says, "my guess is they'll behave."
Alix Nyberg Stuart is senior writer at CFO.